If European
leaders hoped Cyprus would use its turn at the helm of the EU’s rotating
presidency to signal a break from itslongtime benefactors in Moscow, the country’s
Russian-educated communist president made clear on Thursday they would be
disappointed.

A week after
becoming the fifth eurozone countryto
seek a bailout from Brussels, Demetris Christofias said his
government would continue to seek rescue loans from the Kremlin – in essence,
playing one potential creditor off the other.

While Cyprus has requested European Union
support, no offer has been made yet. A “Troika” evaluation mission to Nicosia
started this week, but the complete package will not be defined for some weeks
to come.

Given that neither Russia nor the Troika
are “bidding” to lend money to Cyprus, I fail to see how this amounts to
playing one creditor off against the other.

Cyprus is following multiple courses of
action to redress its urgent financial problems, which mainly involve bank
recapitalisation. As a sovereign country, it has every right and indeed the
responsibility to do so.

The German bilateral relationship with
Russia is far stronger in terms of trade, investment and gas (see for instance former Chancellor Gerhard
Schroder’s chairmanship of North Stream). If we apply the author’s logic to
Germany, should we understand that Germany too needs to separate itself from
“longtime benefactors in Moscow?”

It’s also worthwhile noting that there are
far more Cypriots studying and working in the UK than in Russia, and far more
British citizens living and visiting Cyprus each year than Russians. Britain
maintains two
sovereign military bases in the Republic of Cyprus with 3,500 troops
stationed there. I therefore have to question the systematic attempt to
demonize Russia in this article, or for that matter, the Cypriot relationship
with Russia.

The author also misstates the facts of Cyprus’s
relationship with Turkey:

Cyprus
has not only blocked progress on Turkey’s membership of the EU but it has
prevented the EU from working more closely with Nato to co-ordinate European
defence policies.

This statement is both factually wrong and
misleading:

· It is wrong in that the Cypriot
veto over Turkey’s membership in the European Defence Agency has prompted Turkey’s veto
of EU coordination with NATO. Cyprus is not blocking EU coordination with
NATO—Turkey is. This is an elementary fact which should have been checked prior
to publication.

· It is misleading because it
fails to mention that via the Ankara
Declaration, Turkey neither recognises the Republic of Cyprus, nor has it
opened its ports and airports to Cypriot ships or airplanes. This is what has
prompted Cyprus to veto Turkish membership in the EDA, but has also prompted
the European Union to freeze negotiations on 8 chapters of the Acquis
communautaire.

· It fails to include the fact
that Nicholas Sarkozy
and Angela Merkel
have both called for an alternative membership status for Turkey, and that this
too has played a negative political role in Turkey’s EU accession process.

When a large number of Central and
Eastern European countries joined the EU in 2004, it became necessary to
include them in the EU-Turkish customs union. To that end, the Ankara Protocol,
an additional protocol to the Ankara Agreement, was signed on 29 July
2005. Turkey issued a declaration expressing its continuing non-recognition of
the Republic of Cyprus and explicitly excluding Cyprus from the customs union.
The European Union issued a counter-declaration rejecting this interpretation
and thus re establishing the obligation to include the Republic of Cyprus
without exception. Turkey is nonetheless still failing to uphold the free
movement of goods created within the customs union in the form of free access
to Turkish territory for Cypriot ships, aircraft and heavy goods vehicles. The
Council of the European Union has repeatedly criticized this treaty violation,
deciding in December 2006 on a partial suspension of accession negotiations.
Until the Cyprus conflict is resolved and Turkey implements the Ankara Protocol
without discrimination, eight chapters in the negotiations will remain unopened
and no chapter will be closed. Because of the continuing lack of progress on
the implementation of the Ankara Protocol, the Council has renewed this
decision annually since 2006.

I bring up these facts solely to illustrate
the full picture—not to justify the political decisions on any side which has
led Turkey and Cyprus into this regrettable situation.

I honestly have to question how an article
with such visible bias, and with such a one-sided view of the situation, can be
published in the Financial Times, particularly coming at the beginning of the
Cypriot EU Presidency.

I've had the enormous privilege of working over the years in all three countries: Greece, Cyprus, and Turkey. Through my work, I've interacted with thousands of business owners and managers in this time, as well as journalists, NGO members, government officials, and many others.

Like many others, I believe that Greece,
Turkey and Cyprus have more to gain from working together constructively and peacefully
rather than engendering a permanent state of military and political aggression. Geographic reality, together with our shared culture and our tremendous economic synergies and
potential should make that obvious to anyone.

What should also be obvious are that while
there are serious problems on all sides of the political equation,
well-meaning partners could solve these if we would put aside the vested
interests, stereotypes, political posturing and the bitter memories of the
past, and concentrate on our shared—and inevitable—future.

This would require a rational, post-nationalistic
approach to policy, which I believe citizens in all three countries are ready
for, and indeed would welcome. I have particular hopes that the positive
impacts of globalisation and mobility, and the common interests of younger generations will
one day make this vision a reality.

Unfortunately, articles like this do more
to encourage misconceptions and hostility than to present an accurate and
objective picture of current affairs.

A list of sources follows for anyone
interested in a more complete picture of the political situation between Cyprus
and Turkey.

Monday, 2 July 2012

Friday’s announcement that the European
leaders of the Eurozone agreed to use the European Stability Mechanism (ESM) to
recapitalise Spanish, Italian and other banks was met with euphoria.

Under the preliminary agreement, the ESM
will be able to use part of its EUR 500 billion credit reserves to participate
in bank recapitalisation, subject to certain conditions which include the
development of a pan-European banking regulator under the European Central Bank
(ECB) as well as a wider national commitment to an austerity / balanced budget
programme.

Several commentators have already remarked
that the agreement lacks detail. I will go a step further and argue that the
dual mechanism of European banking regulation plus bank recapitalisation will
fail to prevent future situation equivalent to that where Spanish banks need recapitalisation. While the recapitalisation may take place and provide momentary relief for the "zombie banking system", the root causes of the problem remain, while regulatory compliance will prove impossible to implement.

The reasons for this are based in two
salient facts: recent history, and regulatory operations. If we look at the
emerging market debt crisis of 1982; the US savings and loan crisis of 1987;
the east Asian currency crisis of 1997-1998; the dot.com boom and bust of
1999-2000; the mortgage/property crash of 2007-2008; and the sovereign debt
crash of 2009 and onwards, we readily see that these crises were caused by an
excess of capital chasing outsized returns from a relatively few real
investment opportunities.

This search for outsized returns is
possible either at the early stage of the boom, or by taking on massive
leverage, or by finding gullible investors, or by illegal activity. Or a
combination. But the longer a boom continues, the more difficult it becomes to
regularly earn high returns. Market saturation results; the good opportunities
are taken; competition lowers margins for everyone. As a result, bubbles burst.

In each of the cases mentioned, the initial
investments and subsequent credit or investment booms were entirely legal.
There was nothing inherently illegal, for instance, about dot.com stocks being
valued at 200 times earnings. Similarly, there was nothing illegal about
adjustable rate mortgages, or sovereign loans to Greece.

The problems occurred when too many
institutions starting throwing too much money at too few opportunities. This is
a common factor in most boom-bust cycles, but it has usually has little to do
with regulation.

This is not to say there were regulatory
failings: there were many, and these have been widely documented after each
crash.

But during the boom, a common
factor is that the power to regulate loses its political acceptability in
inverse proportion to the outsized profits being made.

Let’s look at the Spanish bank
recapitalisation as a case study. Spanish banks are currently in dire need of
recapitalisation primarily because the Spanish property market boomed in the
1990s through to about 2005. This investment boom was very well known and
widely reported. See The
Economist’s survey of Spain in June 2004 as an example:

The first problems for
the new government are the demand for housing, which is such a large component
of general economic growth, and the supply of labour, which also drives growth,
though by boosting jobs, not productivity. Spain made a start on 700,000 houses
last year, four times as many as Britain. Even so, prices for new Spanish
houses rose 18.5% and for existing ones 16.7%. The boom continues, fuelled
partly by foreigners drawn to Spain by the thought of a house in a sunny part
of the euro area, partly by share-shy Spaniards looking for an investment. The
upshot is that though 3m-4m houses stand empty and a similar number are used as
secondary residences, many young Spaniards cannot afford even the smallest
flat, and thousands of workers turn down job offers that involve moving house
because they cannot find a house to move to. At the same time household
indebtedness has risen sharply (nearly half of the average family's disposable
income goes on servicing housing debt), while some 40% of Spanish capital stock
is in nothing more productive than property.

This single paragraph summarises everything
wrong with the Spanish economy at the time.

Remember that in
the mid-1990s, the whole objective of economic development in Spain under
standard EU procedures was to attract domestic and foreign investment and promote
economic growth. One of the main beneficiaries of the Spanish property boom was
British and German vacationers, and speculators. Some of the main sources of
capital for property development in Spain came from British and German banks.

The problem was—and
remains—that nothing about the Spanish real estate boom was illegal, or even
unsustainable, unless financers, customers and regulators were to have taken a
much longer-term, conservative view.

So let’s assume
the impossible: that a long-term, “economically rational” or conservative view
prevailed among public policy makers, bankers, developers and customers. What
could have regulators done to stem the property rush? There are several classic
policies, ranging from requiring a greater deposit ratio for mortgages, to
increasing a transaction tax on frequent sales of homes in order to avoid “flipping”
or other speculation.

All these tools
exist. But experience shows us that applying them is nearly impossible.

Now let’s
fast-forward to the ESM and the ECB. Thus far, the European Central Bank has
been placed in a nearly-impossible task of maintaining a Euro-wide inflation
target while providing liquidity to European banks. Along the way, it has
purchased over EUR 200 bln in sovereign debt, which it is not supposed to do, and
also lent over EUR 1 trillion to European banks under LTRO, not counting
additional loans previous to LTRO.

What exactly is
this ECB bank regulator supposed to do in the next boom? Order Spanish banks to
stop lending for property development? Insist via the Eurozone economic
planning committee that Spanish property taxes should rise by 10% to discourage
speculation? Force Spanish banks to increase the deposit ratios to 40% of
mortgage loans?

Does anyone
realistically see this happening?

Most Eurozone countries, including Germany,
have been in breach of the Maastricht criteria since their inception. These
criteria underpin the European convergence criteria, and therefore the basis of
European monetary policy. Let’s remember what these criteria are:

1. Inflation no higher than 1.5%
of the average three best performing member states in the EU

2. Annual government deficit not
more than 3% of GDP

3. Government debt not more than
60% of GDP

4. Long-term interest rates not
more than 2% higher than the rates of the three lowest-inflation member
states.

These criteria are the real problem in the
Eurozone crisis. They impose an inflexible, rigid set of macroeconomic and
fiscal standards which are almost impossible to apply in a monetary community
of 17 member states, which pack small, service centres such as Ireland, Cyprus
and Malta alongside larger economic powers such as Germany or France. They are
also impossible to enforce given the lack of a single, elected budgetary and
decision-making authority (which is ironically what Germany is trying to
develop).

These criteria themselves have fed the
economic boom-bust cycle. As countries with weaker government economic planning
and weaker enterprises such as Spain, Italy or Greece entered the Eurozone,
they saw interest rates fall, leading to a massive credit expansion in both the
public and private sectors. This credit expansion was fuelled by lower interest
rates, and by the fact that credit was secured not only by normal economic
conditions, but by the very convergence policies and infrastructure spending
channelled through the European Union (Common Agricultural Policy, Structural
Funds, etc.).

The results today are clear: there has been
a massive transfer of credit and investment from better-developed capital
markets in northern Europe (and Asia and North America) into the southern
European countries. This was used for everything from capital investments (hospitals,
highways, ports, schools) to private homes to luxury consumption (imports of
Porsche Cayennes and Hugo Boss suits).

Eventually, the boom turned into a bust,
either in terms of the state-led development model (Greece) or the property /
tourism boom (Spain). Now creditors and lenders are left with non-performing
loans and deteriorating public and private assets that are rapidly losing their
value.

The classic solution in this case is a debt
restructuring and work-out. It is not a EUR 100 billion recapitalisation in
exchange for “better regulation”, which will be politically impossible to
implement.

The sooner Greece, Spain and other
countries (including the UK and Germany) come to terms with re-pricing asset
values and their associated debt service assumption, and restructure these
loans contracts, the sooner the crisis will end and “normal” growth will
resume. Until the next bubble, of course.

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